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Evidence from Judiciary Decision Events on Controlling Shareholders in Large Business Groups

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Evidence from Judiciary Decision Events on Controlling Shareholders in Large Business Groups Estimating the Value of Absolute Power: Evidence from Judiciary Decision Events on Controlling Shareholders in Large Business Groups Changmin Lee Hanyang University Business School 222 Wangsimni-ro, Seongdong-gu Seoul, Korea, 133-791 [email protected] Hansoo Choi Korea Institute of Public Finance 1924 Hannuri-daero Sejong, Korea, 339-007 [email protected] 1 Estimating the Value of Absolute Power: Evidence from Judiciary Decision Events on Controlling Shareholders in Large Business Groups Abstract This paper estimates the impact of judicial decisions, mainly the prosecution and court sentencing of controlling shareholders’ corporate crime, embezzlement, and breach of fiduciary duty, on the market value of a firm. The indictment or imprisonment of controlling shareholders in Korean large business groups, chaebols, provides an experimental setting for analyzing the absence of the real boss. Our main findings are as follows. First, judicial decisions relating to controlling shareholders generally do not have a significant group-wide effect on the value of a firm. Second, the portion of firms that receive a positive impact and a negative impact from having a controlling shareholder held in custody is almost equivalent (46% versus 54%, respectively). In situations where there is a court appeal, the portion of firms that receive a positive impact decreases to 38%, while the portion of firms that receive a negative impact increases to 62%. Third, the effect of court decisions on affiliated firms within the same business group is asymmetric. For instance, such decisions have a positive effect on affiliates where a controlling shareholder holds a large proportion of the shares; however, they have a negative impact on affiliates thought to be more likely to grow at faster rates in the future. For this reason, sentencing of the controlling shareholder itself induces value transference between the different affiliated firms in a given company group. Keywords: Family Firm, Controlling Shareholder, Corporate Crime, Judicial System, Event Study JEL classification: G30 2 Introduction The controlling shareholder is one popular research topic in the field of finance, especially in governance. Many studies provide theoretical discussions on the benefit and cost of controlling shareholders (Shleifer and Vishny, 1986; Admati, Pfleiderer, and Zechner, 1994; Huddart, 1993; Noe, 1997; Maug, 1998). La Porta et al. (1999) provide empirical evidence that the existence of a controlling shareholder in firm ownership structure is a global phenomenon that includes developed countries. Anderson and Reeb (2003) argue that it is hard to conclude that family ownership of firms is less efficient than non-family owned firms. The literature is divided into the presence of controlling shareholders with direct involvement in management (Faccio and Lang, 2002; Gadhoum, Lang, and Young, 2005, Villalonga and Amit, 2006b); deviations in controlling shareholders’ cash flow and voting rights (Claessens, Djankov, and Lang, 2000 for East Asia; Joh, 2003 for Korea, Bennedsen, Morten, and Nielsen, 2005 for Western Europe, Villalonga and Amit, 2006b for the United States; Barontini and Caprio, 2006 for Continental Europe); and the impact of management succession on firm performance (Francisco Perez-Gonzalez, 2006; Villalonga and Amit, 2006b). Korean conglomerates, chaebols, have provided meaningful conclusions in this field because the controlling shareholder (i.e., so-called owner) has an important position in addition to being a large shareholder. Owners are often directly involved in company management. Through complicated governance (e.g., pyramids), owners also exercise control over all affiliated firms within the group. In addition, most reigns are inherited. We analyze the effects of judicial decisions regarding criminal acts, embezzlement, and breach of fiduciary duty on the market value of a firm. It can be easily anticipated that the prosecuting or sentencing of controlling shareholders has a negative effect on the value of a firm. The temporary absence of the owner due to the outcome of a court decision (e.g., directly by indictment or imprisonment, or indirectly by involvement in a criminal action or stepping down from the CEO position) can have a negative impact on management. Also, prosecuting or sentencing controlling shareholders can seriously damage a firm’s reputation. 3 The imprisonment or taking into custody of a controlling shareholder provides an experimental setting for analyzing the absence of a company’s boss. Police custody is the first stage of law enforcement, and can cause the first effects on market values. Imprisonment after a court’s final decision is the final stage of law enforcement, and provides a situation where there is no more uncertainty about affecting the market’s expectations. The recent health issues of Lee Kun-Hee, Samsung’s chairman and CEO, provided important motivation for our paper. During this period, Samsung’s stock prices moved asymmetrically. Some affiliated firms increased and others decreased during the shareholder’s health issues. There seems to be no reason why the hospitalization of a controlling shareholder would have a positive effect on the firm’s fundamentals. Therefore, this market change can be interpreted as investors expecting value transfer (i.e., tunneling) between Samsung’s affiliated firms. In other words, the absence of the controlling shareholder might induce the transfer of affiliated firms’ resources and values through various means. In the Samsung case, investors anticipated tunneling to the future holding company where Lee Kun-Hee and Lee Jae Young, son of Lee Kyn-Hee, hold large portions of shares. Our paper is similar to Bennedsen, Pérez-González, and Wolfenzon (2011), which provided evidence for the effect of CEOs on firm performance resulting from the number of days a CEO was hospitalized. They concluded that CEOs meaningfully affected firm performance. In this paper, we focused on controlling shareholders who have real authority over all affiliated firms within the same business group. We analyzed the variation of value effects among all affiliated firms. Moreover, we contributed to the literature as follows. Our paper is an event study about the value of controlling shareholders as part of the top management team. The literature related to our paper was divided into three categories. The first was the effect of controlling shareholders on the policy and performance of a firm (Baek, Kang and Park; 2004, Bertrand et al; 2008; Anderson, Duru, Reeb; 2009). We estimated the effect of a controlling shareholder’s temporary absence on the market value of a family firm. 4 The second category included event studies about the value of a firm when an unexpected turn-over or sudden death happened to the CEO (Furtado, 1987; Weisbach, 1988; Bonnier and Bruner, 1989; Furtado and Karan, 1990; Kang and Shivdasani, 1995; Dedman and Lin, 2002; Salas, 2010). We provided empirical evidence for what happened to all affiliated firms within the same business group when the controlling shareholder was absent. Lastly, many studies showed that tunneling occurred by the controlling shareholder (Shin and Park, 1999; Bae, Kang and Kim, 2002; Campbell and Keys, 2003; Joh, 2003; Baek, Jang and Lee, 2006; Bae, Cheon, and Kang, 2008). Among the above studies, our paper is methodologically similar to Bae, Cheon and Kang (2008). They showed how affiliated firms’ stock prices changed when one affiliated firm within the conglomerate announced an operating profit increase, a positive event. We suggest the possibility that the absence of the controlling shareholder could cause a similar phenomenon due to the expectation for corporate governance restructuring or a succession of control to the next generation. Our main findings are as follows. First, judicial decisions related to controlling shareholders generally do not have a significant group-wide effect on firm value. Second, the portion of firms that received a positive impact (46%) and a negative impact (54%) from having a controlling shareholder held in custody was almost equivalent. In situations where there was a court appeal, the portion of firms that received a positive impact decreased to 38%, while the portion of firms that received a negative impact increased to 62%. Third, the effect of a court decision on affiliated firms within the same business group was asymmetric. For instance, this had a positive effect on the affiliate at which a controlling shareholder held large portions of shares. However, it had a negative impact on the affiliate most likely to grow fast in the future. That is, sentencing of the controlling shareholder itself induced value transference between affiliated firms. 5 Sample Our corporate crime samples covered events violating Korea’s Article 356 of Criminal Law regarding embezzlement and breach of fiduciary duty. We excluded samples regarding collateral frauds, and included banking and accounting fraud. Within a conglomerate, tunneling can occur by transferring resources from one firm to another underperforming firm. Another method is transferring resources to other firms where it is easier to use the resources privately. A third way is transferring resources to commit finance accounting fraud, which is generally conducted to support troubled firms within the conglomerate. Our study sample was composed of 18 business conglomerates, chaebols, which committed white-collar crime in Korea from 2000 to 2014. All of the conglomerates were
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